Do Islamic banking customers hold the keys for sustainability in Islamic finance?

A survey of retail banking customers of Islamic banks shows wide-scale enthusiasm for sustainability and a belief that Islamic finance aligns well with the SDGs. However, the challenges posed by ESG risks and concerns about greenwashing make it increasingly urgent that Islamic banks maintain customer confidence. This should lead to an expanded focus on financing the climate transition and adaptation, and other investments that deliver ESG risk mitigation and support sustainable economic development.

• A recent survey of retail Islamic banking customers from a range of countries found a shared interest in sustainability, even if it costs them more
• Islamic banks will have to avoid the gap between retail customers’ priorities and corporates’ sustainability capabilities if they are to steer clear of greenwashing risks
• Customer willingness to pay for sustainability — especially in the Global South — could help Islamic banks build their resilience to future ESG risks if they can show their impact

Retail banking consumers at Islamic banks identify strongly with their ethical promise, and that has created a customer base that values — and identifies as being willing to pay for — financial services that align with the Sustainable Development Goals. The findings, part of an Islamic Finance and the UN SDGs survey conducted by the Global Ethical Finance Initiative (GEFI), show an identification by retail Islamic banking customers with sustainability through Islamic finance, although priorities differ among customers in different part of the world.

There were differences among consumers from countries classified in the report as the ‘Global North’ (UK and Australia) when compared with the ‘Global South’ (Nigeria, Pakistan and Malaysia). Of the different issues addressed by the Sustainable Development Goals, the greatest proportion of survey participants selected ‘reducing poverty and hunger’ as an important focus.

The survey was conducted by GEFI and distributed with help from five Islamic banks in the UK, Australia, Nigeria, Pakistan and Malaysia to garner a wide range of opinions on the links between sustainability and Islamic finance. It included responses from consumers of all ages, although there were many more men (84%) than women, and by a much wider difference than the share of accounts held by each gender in the sampled countries according to the World Bank’s Global Findex database.

Digging into the details shared by GEFI in the new report, the shares of respondents from the Global North highlighting the importance of the environment & climate change, equality & justice, and sustainable economic development were about even. However, among respondents from the Global South, sustainable economic development was viewed as an important focus more frequently than the other two issues.

It’s unlikely that this means consumers there aren’t interested in equality, the environment or climate change, but they may see less of a potential trade-off between long-term outcomes and immediate opportunities from sustainable economic development, especially in the context of economic challenges experienced to varying degrees across the surveyed countries grouped as the ‘Global South’.

One indication that it is a degree of immediacy that takes precedence for consumers from the Global South is that more consumers were familiar with impact investing than were those in the Global North. Consumers in the Global South were also more willing to pay more for SDG-aligned products, and were on average willing to pay a larger premium for it than among consumers in the Global North.

One takeaway could be a continued willingness to pay a premium for Islamic finance, but with a stepped-up expectation about the degree of impact that it can deliver when compared to conventional finance. The continued growth of Islamic finance assets in US$ terms, despite the depreciation of several Islamic market currencies, would support the proposition that Islamic finance — and retail Islamic banking in particular — still has the opportunity for continued growth as a form of responsible finance.

However, another view that is consistent with the data is that many consumers of Islamic retail banks, especially those in the Global South, see Islamic banks as the closest available alternative to express their ethical and sustainability-related priorities. If this view explained some of the appeal for Islamic banks, then it could indicate both a current strength of Islamic finance and a future vulnerability.

As ESG expands to become commonplace across more of the world, there will be more options and more financial institutions providing ‘sustainable’ alternatives. This poses a challenge to Islamic banks, not on the basis of their Shariah-compliant status, but on how they demonstrate the differentiation of their contribution on important sustainability topics.

One issue that may present a risk is the prospect that Islamic banks’ appeal on sustainability is more limited when it comes to the customers to whom they provide financing than it is to retail banking customers. If Islamic banks see sustainability expectations rising from retail customers but don’t see sustainability-related financing demands coming from companies, they will need to walk a fine line in explaining the sustainability of their products over-and-above their Shariah governance processes and safeguards. At the same time, they will face commercial pressures to attract customers whose financing will support competitive deposit rates.

If the pricing advantage for SDG-aligned products among Islamic banks’ customers is as robust as the survey indicates, Islamic banks should use it to fortify their products against any questions about greenwashing. Greenwashing concerns have hit banks around the world, but Islamic banks stand more to lose because of their explicit ‘ethical’ orientation.

If Islamic banks can maintain their retail customer base while they build a range of offerings for customers who may not be as familiar with sustainability, then this could have a two-fold benefit. First, they may be able to move more aggressively than their conventional competitors, whose customers are less attached and more sensitive to price. And by moving more aggressively, they may stand to gain more of the benefit from mitigating ESG risks for their customers, which could expand on their competitive advantage without becoming reliant on a customer subsidy to them for sustainability.

Take climate change, for example. An Islamic bank, especially one in an emerging or developing country, may struggle to find ‘green’ assets to develop a climate-sustainability deposit product. However, the economy-wide risks from climate change are amplifying, and customers who are more at risk from climate-related physical or transition risks will see the risk premium they have to pay rise over time unless they make resiliency or transition investments today.

If Islamic banks can compete on adaptation or transition finance, they may end up in the future with a customer base that is otherwise similar to conventional banks but less susceptible to climate risks. In doing so, they would have shown a tangible positive outcome from a customer base held together around a shared belief in sustainability achieved through Islamic finance.

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